CHINACAST EDUCATION CORPORATION v. MOZART MANAGEMENT CO LTD AND OTHERS

HCA 2105/2016

[2018] HKCFI 851

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2105 OF 2016

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REASONS FOR DECISION

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1.  This is an application by the plaintiff under O.24 r.7 for specific discovery of documents by the 2^nd and 3^rd defendants.

2.  At the end of the hearing I order discovery in terms of paragraph 1 of the plaintiff’s summons dated 24 November 2017 with certain amendments and dismiss paragraph 2 thereof and award 70% of the costs of this application to the plaintiff.

3.  Here are my reasons.

4.  For ease of reference, when I refer to the 2^nd and 3^rd defendants together I shall use the expression “the Defendants”.

Background

5.  The background so far as material to the present application can be briefly stated.

6.  The plaintiff is a company listed since October 2007 on the NASDAQ stock market.  Very generally described, it has been carrying on the business of providing education and e-learning, in a number of countries, notably in PRC.

7.  There was a substantial change in its board of directors in early 2012 after a proxy contest.

8.  The new board discovered there were substantial funds being misappropriated.  HCA 1062/2012 was then commenced by the plaintiff and its associated companies against members of the old board and other parties.  Default judgment was entered against two members of the old board; relevant to this action and one of them, was one Ron Chan.

9.  This present action was commenced to claim against the 3 defendants regarding 2 batches of funds misappropriated (“the Funds”) which are described and defined in the Statement of Claim as Batch 1 Transfers and Batch 2 Transfers.

10.  The 3^rd defendant is a public company listed on the stock exchange of Singapore.  The 2^nd defendant is its almost wholly owned subsidiary (99% according to the plaintiff, 99.99% according to the Defendants).   One Mr. Tang (“Tang”), one Ms. Teo (“Teo”) and one Mr. Wu (“Wu”) were at the material times the directors of the 3^rd defendant. Teo and Wu were then also the directors of the 2^nd defendant.

11.  The 1^st defendant is a BVI company. Tang and Teo were at the material times its directors.  Little is known as to who then owned or now own its shares. Thus far, the 1^st defendant has not filed its acknowledgment of service.  Default judgment has not been entered against it.

Batch 1 Transfers

12.  The plaintiff claims that a total sum of HK$22,297,330.68 (US$2,857,500.24) was misappropriated by the same having been transferred from the Bank of China account no. 031-351-9-208545-0 held in the name of ChinaCast Technology (HK) Ltd. (“CCTHK”)(“CCTHK BOC Account”) to the HSBC account no. 485-354302-001 held in the name of the 1^st defendant (“D1 HSBC Account”), as follows :

Date	Amount of transfer (HK$)	Equivalent amount in US$
1 March 2007	10,000,000.00	1,281,558.37
1 March 2007	10,297,150.68	1,319,639.97
2 March 2007	2,000,180.00	256,301.90
Total:	22,297,330.68	2,857,500.24

13.  CCTHK was a subsidiary of the plaintiff in Hong Kong.  It did not have its own business operation or source of income.  It was used to hold funds of the plaintiff and to transmit them to the plaintiff’s business use in Hong Kong and in PRC.

Batch 2 Transfers

14.  The plaintiff claims that another US$8.4 million was misappropriated by having been transferred on 2 October 2008 from its US account with Signature Bank (no.1500455884) to the CCTHK BOC Account.

15.  The next day, CCTHK transferred US$4 million to D1 HSBC Account.

16.  3 days later on 6 October 2008, the 1^st defendant issued 8 cheques drawn on D1 HSBC Account, and on 9 October 2008, another 2 cheques also drawn on the same account, all to the 2^nd defendant (“the 10 Cheques”).  Their details are as follows:

Date	Cheque number	Amount (HK$)
6 October 2008	491694	3,344,586.00
6 October 2008	491695	3,318,303.00
6 October 2008	491696	1,867,905.00
6 October 2008	491697	1,872,826.00
6 October 2008	491699	1,916,789.00
6 October 2008	504328	6,829,372.00
6 October 2008	504330	4,569,539.00
6 October 2008	504332	5,974,537.00
	Total:	29,693,857.00
9 October 2008	483475	234,000.00
9 October 2008	483476	1,076,400.00
	Total:	1,310,400.00
Grand total:		31,004,257.00

The plaintiff’s case

17.  The plaintiff’s case is that

a)  the 3 defendants were, at the material time and loosely speaking, managed and controlled by Tang, Teo and Wu;

b)  Tang, Teo and Wu had close business tie with Ron Chan, they having been at different points in time co-shareholders and/or co-directors in a number of companies, including one ChinaCast Communications Holdings Limited, which was the predecessor of the plaintiff, the 2^nd defendant and some others; and

c)  the plaintiff had no business or other relationship with any of the defendants and had no reason to make the said transfers or payments.

18.  The plaintiff now claims against the 3 defendants as bare trustees or constructive trustees of the Funds, and as liable to restitutionary or tracing claims or liable for loss and damages in respect of them.

The Disclosure Report published by the 3^rd defendant

19.  The plaintiff also pleads and relies on an Announcement dated 22 April 2016 made by the 3^rd defendant (“the Announcement”) and the report published by the 3^rd defendant on the findings of certain investigations concerning issues of irregular accounting practices (“Disclosure Report”).

20.  In gist, it is pleaded by the plaintiff that the Disclosure Report revealed that certain receivables recorded in the books of the 2^nd defendant for the years 2008 and 2009 as owed by certain import export firms were in fact bogus entries.

Defence of the Defendants

21.  Their defence, in gist, is that

a)  They deny the Funds and/or their traceable proceeds had been remitted to them; and

b)  The 2^nd defendant received the Batch 2 Transfers as a bona fide purchaser for value without notice.

22.  The Defendants claim that the 2^nd defendant engaged in the provision of information technology solutions (“IT Solutions”) and regularly received order from “customers known as “import/export firms”, “which acted as distributors to, or agents of, the end users” (§21(1) of their Defence).

23.  They claim that the Batch 2 Transfers received by the 2^nd defendant were payments for IT solutions provided by the 2^nd defendant to the “import/export firms”; but upon the direction of Tang, Teo and/or Wu, they were paid to the 1^st defendant instead of the 2^nd defendant; and the transfers of the funds from the 1^st defendant to the 2^nd defendant were therefore in effect payments for the IT solutions.

24.  It is noted that it is not pleaded the reasons why such sums due to the 2^nd defendant were paid to the 1^st defendant; nor is it pleaded the nature of such payments to the 1^st defendant, such as whether they were loans by the 2^nd defendant to the 1^st defendant or whether they were repayments of debts due.

25.  Schedule 3 to the Defence then lists out 26 invoices issued by the 2^nd defendant to the “import/export firms” as being the “underlying sum” payable by these firms to the 2^nd defendant connected with the Batch 2 Transfers.

26.  In the said Schedule 3, it is stated that “The delivery of goods” relating to those invoices were made from 1 February 2007 to 15 February 2008 with the majority of them made in the year 2007. Then, there were 7 invoices the delivery dates of the goods in respect of which are not stated.

Applicable principles

27.  The applicable principles are trite and are not disputed.  They can be briefly stated (§24/7/2 Hong Kong Civil Procedure 2018; Jade’s Realm Ltd v. Director of Lands [2014] H.K.E.C. 978) :

a)  There is no jurisdiction to make an order under O.24 r.7 unless there is sufficient evidence or prima facie case that

(i)  The documents or classes of documents exist which the other party has not disclosed;

(ii)  The documents relate to a matter in issue in the action; and

(iii)  The documents are in the possession, custody or power of the other party.

b)  Once satisfied that these 3 prerequisites exist, the court has a discretion whether or not to order discovery;

c)  The court will not make an order unless the discovery sought is necessary either for disposing fairly of the cause or matter or for saving costs;

d)  The well known test of Peruvian Guano remains the test for relevance;

e)  For the purpose of discovery, the pleadings have to be looked at broadly; and

f)  Notwithstanding the Peruvian Guano test, “fishing” is not allowed and discovery should not be oppressive.

Request 1 in Schedule 1 to the plaintiff’s summons

28.  This seeks discovery of bank vouchers of the 2^nd defendant’s bank accounts for the transactions set out in the table below :

Date	Transaction summary	Withdrawal (HK$)
Bank of China account of the 2nd defendant Account no. 031-351-1-094019-1
2008/10/08	NTR EXCH USD 7.774 CBS TRANSFER	2,730,000.00
2008/10/09	NTR CBS TRANSFER	3,732,873.00
Hang Seng Bank account of the 2nd defendant Account no. 266-545383-668
2008/10/10	BANK TRANSFER 22272H801QEH	753,480.00
2008/10/10	BANK TRANSFER 89822H801R7T	4,560,964.00
HSBC account of the 2nd defendant Account no. 636-154411-292
2008/10/06	TT NSC713767 REMIT USD319,987.15	2,489,760.00
2008/10/08	TT NSC717489 REMIT USD30,601.98	238,155.86
2008/10/08	TT NSC716807 REMIT USD300,000	2,333,050.00
2008/10/08	TT NSC921075 REMIT HKD4,958,962.92	4,958,962.92
2008/10/08	TT NSC921073 REMIT HKD4,958,963.54	4,958,963.54
2008/10/08	TT NSC921074 REMIT HKD4,958,963.54	4,958,963.54
Total:		31,715,172.86

29.  So far as can be ascertained from the bank statements discovered by the 2^nd defendant, the 10 Cheques were deposited into the above 3 accounts and were essentially immediately transferred out by the transactions listed above to unknown third parties. This is not disputed by the Defendants.

30.  The Defendants also do not dispute the existence of the requested bank vouchers or that they are in their possession or control.

31.  The plaintiff submits that it is entitled to trace the whereabouts and to know the identities of the recipients of these transfers.  Such information could not be ascertained from the bank statements already disclosed.

32.  The plaintiff further submits that the identities of the recipients are also relevant to the 2^nd defendant’s own case that it was a bona fide purchaser for value without notice.

33.  The Defendants’ argument is that the whereabouts of the funds and the identities of the recipients are irrelevant to any of the issues to be resolved.

34.  With respect and without hesitation, I reject the Defendants’ such argument.

35.  Whether the 2^nd defendant received the funds paid to it by the 10 Cheques as a bona fide purchaser for value without notice is one of the key issues, which opens up, among others, an examination as to whether the transactions themselves as well as the connected transactions were genuine and in the normal or usual course of business of the 2^nd defendant.

36.  In that regard, whether the recipients of these transfers from the 2^nd defendant were parties that would otherwise have received such substantial amounts in the usual or normal course of the 2^nd defendant’s business, or in accordance with such transactions as may be recorded and/or documented in the accounting records of the 2^nd defendant, is a question that is clearly relevant.  Therefore, the plaintiff is entitled to know the identities of the recipients.

37.  I therefore hold that the plaintiff is entitled to the discovery as sought in Request 1 in Schedule 1.

Request 2 in Schedule 1 to the plaintiff’s summons

38.  By this request, the plaintiff sought the management accounts and audited accounts of the 2^nd defendant for the years 2008 and 2009.

39.  At the hearing and after hearing both parties, I allow the plaintiff’s application to amend the summons to seek in this request also the same sets of accounts for the year 2007.

40.  The Defendants’ argument against discovery of these accounts are (a) the request should only be limited to the year 2008 and (b) the 2^nd defendant have already discovered the relevant transaction documents and therefore the request documents are unnecessary for the fair disposal of this action or for saving costs.

41.  With respect, I reject those arguments.

42.  The plaintiff claims that the Disclosure Report revealed that account receivables recorded in the books of the 2^nd defendant for the period of 2008 and 2009 as originated from the “import/export firms” were in fact bogus.  Without the accounts of the 2^nd defendant, it would put the plaintiff in an unfairly disadvantageous position as far as it seeks to substantiate what was apparently revealed in the Disclosure Report, and to try to connect it to the transactions in question.

43.  It can be recalled that it is the Defendants’ own case that the payments made to the 26 invoices set out in Schedule 3 of the Defence were paid to the 1^st defendant who ultimately paid over the same by the 10 Cheques.  Further, in the 2^nd defendant’s such invoices, there was a standard term on payment : “Payment term : 50% 60 days of dly; 30% 60 days of PA; 20% 30 days of FA”.

44.  Therefore, whether the invoiced transactions were booked as turn-over, whether these due payments were actually recorded in the 2^nd defendant’s accounts contemporaneously in the relevant years (2007 to 2009) as receivables, and if not, how were they recorded, how the alleged payments for these invoiced sums to the 1^st defendant were recorded in these accounts and how the purported payments by the 1^st defendant of these invoiced sums to the 2^nd defendant by the 10 Cheques were recorded and the accounting policies of the 2^nd defendant are all relevant.

45.  As to whether such accounts for year 2007 should be disclosed, as the majority of the 26 invoices were dated in 2007, and quite a number of them in February of that year, such accounts for 2007 should be discovered.

46.  For the accounts for year 2009, as the Batch 2 Transfers and the transfers out were made in October 2008, and the financial year of the 2^nd defendant has been the calendar year, there is a possibility that the relevant transactions may have been recorded late and not in the accounts for 2008, but in 2009.  I therefore disagree with the Defendants and take the view that the accounts for 2009 should be discovered as well.

47.  These accounts are also relevant to the issue as to whether the 2^nd defendant was a bona fide purchaser for value without notice.

48.  I am therefore of the clear view that the discovery sought by Request 2 in Schedule 1 as amended is relevant and is necessary for the fair disposal of this action and I allow it.

Requests 1 to 3 in Schedule 2 to the plaintiff’s summons

49.  These 3 requests can be dealt with together. They are :

“1. Bank statements of the 3^rd Defendant’s accounts for 2008 to 2009.

2. Bank vouchers for transactions over HK$200,000 in 2008 to 2009 appearing in the bank statements of the 3^rd Defendant.

3. Management accounts of the 3^rd Defendant [sic] 2008 to 2009.”

50.  In the hearing, the plaintiff sought, and after hearing the parties, was also allowed to amend Schedule 2 to its summons to also seek the above classes of documents for the year 2007.

51.  Mr. Woodrum, the CEO and CFO of the plaintiff in his affidavit filed on behalf of the plaintiff explained the reasons for making these requests (in §19 to 23), in gist, as this : that by obtaining the documents requested, the plaintiff can tally the bank statements, the vouchers with the management accounts to see if there are any inconsistencies so as to ascertain whether any of the Funds “found their way back into the accounts of [the 3^rd defendant] or whether [the 3^rd defendant] has otherwise benefitted from [the 2^nd defendant’s] receipt of the Batch 2 Transfers” (§19).

52.  The plaintiff therefore intends to conduct some sort of forensic investigation with the requested documents to find out if the 3^rd defendant indeed has received or somehow was benefitted from the Funds.

53.  This is a classic example of a “fishing” exercise.

54.  The volume and wide range of documents requested, which clearly cover many transactions of the 3^rd defendant, which is a listed company in Singapore, that are totally unrelated to any of the transactions or transfers in question, are evidently oppressive.

55.  In the hearing, the plaintiff withdraws Requests 2 and 3 and limits Request 1 to cover the periods from 1 March 2007 to 30 September 2007 (within 6 months after the Batch 1 Transfers have taken place) and from 1 October 2008 to 30 April 2009 (within 6 months after the Batch 2 Transfers have taken place)(“the Limited Periods”).

56.  The Defendants submit that the same objections of irrelevance, being a fishing exercise and oppression still hold.

57.  I turn to look closer at the claim against the 3^rd defendant in the Statement of Claim.

58.  It is based on the close ties between Ron Chan and the Defendants through his relationship with Tang, Teo and Wu, the overlapping directorship between the 3 defendants, and that the fact that the 2^nd defendant was wholly owned by the 3^rd defendant, and the following 2 pleas

(a)  “… the Batch 1 Transfers and Batch 2 Transfers were wrongful and constitute part of the Misappropriated Assets converted from the plaintiff in the hands of the 1^st and 2^nd Defendants and, insofar as the 3^rd Defendants [sic] have acted through the 2^nd Defendant as its agent or nominee, the 3^rd Defendant” (§18)(“Paragraph 18 Plea”); and

(b)  “the 1^st to 3^rd Defendants were used by and have conspired with the Old Management Team in respect of the Batch 1 Transfers and Batch 2 Transfers by reason of the close relationship among Ron Chan, Mr. Tang, Ms Teo and Mr. Wu” (§20)(“Paragraph 20 Plea”)

59.  The Paragraph 18 Plea does not in fact allege that the 3^rd defendant was in receipt of the Funds.  It only pleads that “insofar as” the 2^nd defendant was an agent or nominee of the 3^rd defendant, then the Funds “were converted from the plaintiff in the hands of … the 3^rd defendant”.  There was also no clear allegation that the 2^nd defendant in fact acted as an agent or nominee of the 3^rd defendant.

60.  While the Paragraph 20 Plea is an unparticularized assertion that the 3^rd defendant was “used by and [has] conspired with the Old Management Team”.  It is not pleaded how the 3^rd defendant was so used or what its role was in the asserted conspiracy.

61.  The plaintiff submits that the pleadings, and therefore the question of relevance, should be looked at broadly, and much prominence should be given to the following undisputed background facts and context :

a)  There was a massive fraudulent scheme having been perpetrated against the plaintiff with very substantial amount of its funds being misappropriated.

b)  Ron Chan was central to that fraudulent scheme and there is at least a prima facie case of close tie and connection between Ron Chan and Tang, Teo and Wu.

c)  Funds belonging to the plaintiff were actually traced to have been paid to the 1^st defendant (by the Batch 1 Transfers) and to the 2^nd defendant via the 1^st defendant (by the Batch 2 Transfers).

d)  The Disclosure Report published by the 3^rd defendant set out :

(i)  Concerning the “Transactions in Questions” (as specified in the Disclosure Report), the “IE Firms” purportedly acted as distributors or agents of end users, and the 1^st defendant (whose involvement was previously unknown to the 3^rd defendant) purportedly acted as the paying agent of the “IE Firms” to pay for IT solutions provided to the end users, while Tacoma Associates Limited (“Tacoma”) acted as the paying agent purportedly making payment by the 2^nd defendant to “PRC Suppliers” in relation to the same IT solution (pp.4 and 31 of the report);

(ii)  However, the existence of the “IE Firms” and “PRC Suppliers” cannot be verified (pp.4 and 31 of the report);

(iii)  There was implication of potential connection between the 1^st defendant, Tacoma, Tang and/or Teo (pp.4 and 31 of the report);

(iv)  Two of the “IE Firms”, namely Beijing Hantz Development and Ming Po Hong were the customers in 15 out of the 26 transactions pleaded by the Defendants in Schedule 3 to their Defence;

(v)  As in the “Transactions in Question”, the 1^st defendant was the “paying agent” and Tacoma was also the agent paying the PRC suppliers in the 26 invoices listed in the said Schedule 3;

(vi)  In paragraph 6(iii)(a) of the report, it is said “For those Transactions in Question, although it is recorded in the accounting books of [the 2^nd defendant] and DMX MCO that the [account receivables] received by [the 3^rd defendant] were originated from various IE Firms, there is insufficient evidence to verify the identity of the actual payer of the said AR …”.  Thus, it seems that the books of the 2^nd defendant recorded that the 3^rd defendant have “received” the account receivables from the Transactions in Question.

62.  The plaintiff therefore submits that it is not a mere suspicion, but a likelihood that the plaintiff’s funds have found their way into the books of, or actually have been received by, the 3^rd defendant; and that the discovery of bank statements for the Limited Periods would at least enable the plaintiff to start a chain of enquiry as to whether the Funds have been paid into the bank accounts of the 3^rd defendant and so on.

63.  However, one must not lose sight that the conclusion reached in the Disclosure Report was that the Transactions in Questions were bogus. While such conclusion and the details provided might go to refute the 2^nd defendant’s defence, they do not ipso facto show that the 3^rd defendant have received or was benefitted from the Funds.

64.  On the contrary, the 3^rd defendant’s Announcement (§1.4) stated that following the findings in the Disclosure Report, it is uncertain as to the collectability of certain unaudited account receivables amounted to approximately US$378 million.  In other words, because the Transactions in Questions were found to be bogus, so were the connected receivables entered in their accounts, which the 3^rd defendant doubted would be collectable.   Thus, the Disclosure Report tends to show that the Funds have not been actually received by the 3^rd defendant, rather than the opposite.

65.  In any event, the matters set out in paragraph 61 above merely explain the plaintiff’s suspicion (regardless of whether it is rightly held), I do not think they are relevant to the application of the principle that for the purpose of discovery, the pleadings should be looked at broadly.  Nor do they, in my view, detract from the fact that the discovery sought is a fishing exercise.

66.  Furthermore, as Mr. Wu appearing for the plaintiff is bound to and does accept, as also deposed to by Mr. Woodrum in §22 of his affidavit, that the information to be provided by the bank statements sought would be limited, such that it is insufficient to connect certain payments-in disclosed in the bank statements to the Funds.  Thus, there is little utility in ordering their discovery.

67.  By the reasons above set out, I refuse to order the discovery sought in Schedule 2 to the plaintiff’s summons.

68.  However, I would make clear that my such refusal is without prejudice to discovery that the plaintiff might later seek, which might include the documents now requested but refused, upon fresh or different circumstances or basis.

Disposal

69.  I therefore make the order mentioned in paragraph 2 above.

70.  Having heard the parties’ submissions as to costs, I think the overall fair costs order is that the Defendants do pay the plaintiff 70% of the costs of this application to be assessed summarily and paid forthwith, and I so order.